Investors Chronicle dividend of the week - 14/10/2013

Investors Chronicle – Dividend of the week – Number fifteen

This week we are going to narrow our horizons and have a look at a single sector. We are going to examine the pharmaceutical sector globally. This sector is characterised by excellent cash flows, high profitability and is high technology. The sector has lost a great deal of the investment glamour that was its hallmark from the 1980’s for a couple of decades. However, picking out the winners is still vital to any balanced portfolio. We will attempt to do this for the reader, especially from an income perspective.

The pharmaceutical sector has been slowly losing its rating over the past thirty years and whilst the biotechnology side has seen some major successes, the area is akin to oil exploration stocks where gains and losses can be extraordinary. No realistic investor would invest in these areas without a huge amount of knowledge to justify their investment. So we will focus on the large Pharma stocks and we will take a global perspective.

The initial criterion is to select the pharmaceutical sector globally and this gives us a list of 21 stocks that are covered by DividendMax.

Our next selection criterion is for a yield of over 3%, based upon looking out over 18 months rather than our usual perspective of the next 3 dividends. This is because most of the companies in this sector globally tend to pay their dividends quarterly. This brings the list down to eleven companies, with the vast majority being from the United States. They are listed below:

Astra Zeneca, GlaxoSmithkline, Eli Lilly, Pfizer, Merck & Co, Teva, Johnson & Johnson, Dechra, Bristol- Myers, Bayer and UCB.

To further reduce the list, we will have a look at their dividend history and consider only those companies that have delivered more than five consecutive annual dividend increases. This brings us to our short list of 5 companies, now dominated by the UK with Astra Zeneca, Glaxo, Teva, Johnson & Johnson and Dechra Pharmaceuticals making up the list.

At this point we can look at the fundamentals:

Astra Zeneca are in the middle of a great deal of change as they try to revamp their business. Teva Pharmaceuticals is a generic drug manufacturer who has grown their dividend strongly over the past few years. GlaxoSmithkline look to be on track to deliver their strategy of de-risking their business by altering the balance between pure pharmaceuticals and softer healthcare products. Johnson and Johnson are a massive company with a market cap of over $200 billion. Dechra Pharmaceuticals is an international veterinary pharmaceuticals business.

For my money, given its size, Johnson & Johnson look too expensive on a P/E of over 16. Teva are undergoing a huge firing programme that will see 5000 employees lose their jobs. They are under pressure as they lose patent protection for its highly profitable multiple sclerosis treatment, Copaxone in 2014. For these reasons, we will eliminate Teva from this analysis and concentrate on the three remaining UK stocks.

Let’s have a look at the dividends paid by each company over the past 6 years:

Astra Zeneca

Astra paid a slightly increased 2013 interim dividend of 59.2p (flat in $ terms)

GlaxoSmithkline

Glaxo have paid the Q1 & Q2 dividends and their Q3 results are 23^rd October

Dechra Pharmaceuticals

2013 final dividend declared at 9.66p, going ex-dividend on 6^th November.

What are the brokers saying about the three survivors? The table below represents the number of brokers in each of the recommendations categories of buy / hold / sell:

Dechra Pharmaceuticals are a good business, but they have the price earnings ratio and relatively low yield to go with it and frankly in 2012/13, the dividend increases did not justify the premium rating so we are going to focus on what is the big two in the U.K.

The battle of the big two has been an intriguing one for investors over the past years and at the moment GlaxoSmithkline looks the better of the two businesses. As always though, the market has priced this in leaving investors with a difficult decision. There is no doubt in my mind, given the international scope of their businesses that the big two British pharmaceutical companies look very good value next to their international competitors. Their price / earnings ratios are low and their yields are way above the pharmaceutical market average.

AstraZeneca are in a period of transition with some of their most profitable drugs losing their patent protection. GlaxoSmithkline are also transitioning their business away from pure pharmaceuticals into a more broad-based healthcare company.

This has to be one of the great investment conundrums and it is very very difficult to call. For the safety first investors, seeing what is on the table, in my view you have to go for GlaxoSmithkline, but the contrarian in me is leaning towards Astra Zeneca. It really is very difficult to assess the acquisitions that they have been making recently and you have to wonder if the corporate governance in the target companies will match that of Astra Zeneca. The case for Astra would be stronger if they were growing organically. However, they do have the stronger balance sheet of the two and can gear up over the coming years for internal R&D spend and additional acquisitions.

Looking at the broker views above suggests that there is a good deal of woe built into the AstraZeneca share price. I am confident that they will maintain their dividend (in $ terms, so UK investors could be looking at a slight decrease), but I like the look of their news flow. GlaxoSmithkline will continue to be a steady Eddy and will produce solid if unspectacular earnings and dividend growth over the next 5 years. However, for me, AstraZeneca are the more exciting prospect and I like the fact that they are remaining a pure pharmaceutical company. There is no doubt that they carry a higher risk than Glaxo, but for me their current lowly rating has more than priced that in. Both stocks are currently sat in the middle of their 52 week trading ranges, so there is no particular pointer there. Our dividend of the week is Astra Zeneca.